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Seed Weekly - Summary of 2015 Performance

The last month of 2015 and then into January 2016 proved to be exceptionally volatile for investments, both locally and globally. The big economic story was the rand weakness in December, which has perpetuated into January 2016. While the rand had been declining throughout 2015, it was sold down heavily in December and further into January. This followed the sudden and politically motivated replacement of the incumbent Finance Minister with an unknown, and then under duress reinstating Nene’s predecessor, Pravin Gordhan.

Over the month of December, the rand weakened by almost 7% to the dollar, bringing the total rand weakness to 35% for the 2015 year. During December all 3 rating agencies delivered downgrades on government debt ratings or to their outlook. Failing drastic action, the next step is possible derating to sub investment grade. Fitch and S&P have review dates in June 2016.

South African government bonds were sold down heavily as investors’ risk assessment of South African investments increased. This translated into an immediate negative impact on holders of SA bonds, property shares and financial shares.

The rising yield is a gauge of the actual and perceived risk that both local and foreign investors have of South African bonds. When other South African investment assets are discounted by the higher yield their price declines, which is exactly what happened to listed property and equities, especially financials.

The chart below is the yield demanded by investors in the R186 government bond. This is a benchmark bond, having the highest weight in the All Bond index.
Chart 1: Yield on the R186

December saw local equities decline by 1.7%, which brought the total return for listed JSE shares to just 5.1% for 2015. This was, therefore, down sharply from the positive 10.9% in 2014, 21.4% in 2013 and 26.7% in 2012, and paints a clear picture of the bull market in local shares coming to a close. In USD terms, local shares fell by 21.5%

Our models have been indicating that local shares have been expensive for some time now, and the lower returns were therefore not too much of a surprise. As always, sector and stock selection was very important, but in 2015 it was particularly the case. At a sector level, in making up the 5.1% return, resources declined a massive 37%, Industrial shares gained 15.3% and financials gained just 3.9%. Clearly, avoiding resources in 2015 was critical.

Secondly, within these sectors relatively few shares contributed to the positive performance of the total return. It has been estimated that excluding the performance of SABMiller, the index would have been negative and excluding the performance of 4 shares - SABMiller, Naspers, British American Tobacco and Steinhoff would have seen a return of approximately negative 7% on the JSE All Share index.

It is clear, therefore, that investors who held little or no exposure to these 4 shares struggled to match the return of the JSE All Share index.

Globally the big news item was the US Federal Reserve raising their core interest rates for the first time since June 2006. This was widely telegraphed to the market and therefore largely priced in. However on the day of the hike the S&P 500 rose by 1.5%, but subsequent action has been negative. The market is pricing in that the US Federal Funds rate will be just 1.75% by the end of 2018. In the light of zero to low inflation, falling commodity prices and excess capacity, the rise in interest rates is expected to be a slow process.

The MSCI All Country World Index ended down 1.8% for 2015. This followed the 5.5% gain in 2014 and the 23.4% gain in 2013. Emerging markets came under immense pressure in 2015 declining 14.6%.

Emerging market declines was partly attributable to the decline in commodity prices and partly due to the currency declines. Brent crude fell sharply in December – down 17% and into 2016 has continued to fall to new multi-year lows. For 2015 the price fell back 38%.

Other commodity prices continued their downward slide during 2015. Copper shed 26% and Platinum 28%. The price of gold in USD fell 10.5% for the year.

The analysis that we receive from research house BCA have been urging all investors to reduce expectations of both real and nominal returns on their investments. As an example for a global diversified portfolio, the nominal annual return from an investment from 1982 to 2015 was 9.7% in USD with average inflation over this period running at 2.7%.

Their expectation for the next 10 years is for that same diversified portfolio to return just 4.5% in USD with developed market inflation running at 2%. In this environment proper diversification, intelligent allocation of capital and a focus on costs becomes even more important than normal.

Seed Weekly - Investing in 2016

Welcome to Seed’s first Weekly of the year. We trust that you had a good break, and have a successful 2016!

The political and financials ructions of the last month or two have been widely discussed and documented across media and around many braais over the summer holiday I am sure – so this Weekly won’t attempt to cover those events. Many people will have come back to their desks this year worrying about their investments, and how they should be positioned.

As professional investors we need to ensure that we separate emotion from fact when making investment decisions. Any sharp (negative) move in an asset class will result in high emotions (panic) and it’s our responsibility to assess why the move has occurred and whether the facts have changed. Should there be no rational reason for the asset class weakness it presents us with an excellent opportunity to buy, but if the facts have changed then the position needs to be reassessed. There is no doubt that South Africa’s global standing has been negatively affected over the past 2 months, but we need to assess to what extent this is now priced in.

Many/most investment companies in South Africa have been advocating having a material allocation to global assets (in a practical sense around 25% as per pension fund (Reg 28) limits) for some time now. The Seed Balanced Fund has been at (or near) its limits for much of its 5.5 year history – and this allocation has significantly contributed to the Fund’s returns. The rationale for most of this period has been that global assets offer better value than local assets and pressure on the rand to weaken.

To the end of October 2015 the rand weakened by 12.8% pa vs the US dollar over a 5 year period (6.96 ZAR/USD to 13.80 ZAR/USD) in a fairly linear fashion. From the end of October 2015 up to yesterday’s (18/01/16) close the rand further weakened by over 18% to the US dollar – a much sharper drop. While we believe that global investments still offer better value than their local counterparts, the argument for significantly more rand weakness has, excuse the pun, been weakened.

The question for investors who’ve had a sizeable allocation to global assets is, “What should I do now? Should I be repatriating my global assets?”

Seed’s view remains that investors should invest into well-constructed, diversified portfolios. We continue to see more value in global assets and therefore prefer to keep the global allocation in our Funds at/near their mandate limits. What isn’t so clear is where the rand will move from here. According to our Purchasing Power Parity (PPP) model the rand’s fair value is R10.42/USD, indicating that at current rates (R16.84/USD) the local currency is over 60% from fair value. The rand has only been weaker (relative to fair value) in the currency blow out of 2001. The chart below shows the rand vs the US dollar since the end of 1984 as well as the PPP level and a couple deviation lines from fair value (PPP). Naturally there is a risk that the rand continues to weaken from here, but history shows that PPP does have a strong pull over longer periods.

Practically, in the Seed Balanced Fund (our house view unit trust), we have implemented a zero cost currency collar on a portion of our global allocation. The structure protects a portion of the Fund from the rand strengthening below R16.47/USD AND allows that portion of the Fund to participate in further rand weakness up to a point (R19.70 – represented in the chart above) by the end of the year, all the while retaining exposure to global assets. Essentially the rand will need to weaken past its (relative) lows of 2001 before this structure starts costing the Fund – another 15% fall in the currency by year end.

We don’t proclaim to have a crystal ball that tells us what level the currency will be at by the end of the year, but based on our valuations (and understanding of global forces) our view is that there is a greater chance of the rand ending the year below R19.70/USD than above. Importantly, this structure is only on a portion of our global assets. Should we see further rand weakness we will have the opportunity to protect more of the Fund’s currency exposure.

Seed Weekly - Investing in 2016

Welcome to Seed’s first Weekly of the year. We trust that you had a good break, and have a successful 2016!

The political and financials ructions of the last month or two have been widely discussed and documented across media and around many braais over the summer holiday I am sure – so this Weekly won’t attempt to cover those events. Many people will have come back to their desks this year worrying about their investments, and how they should be positioned.

As professional investors we need to ensure that we separate emotion from fact when making investment decisions. Any sharp (negative) move in an asset class will result in high emotions (panic) and it’s our responsibility to assess why the move has occurred and whether the facts have changed. Should there be no rational reason for the asset class weakness it presents us with an excellent opportunity to buy, but if the facts have changed then the position needs to be reassessed. There is no doubt that South Africa’s global standing has been negatively affected over the past 2 months, but we need to assess to what extent this is now priced in.

Many/most investment companies in South Africa have been advocating having a material allocation to global assets (in a practical sense around 25% as per pension fund (Reg 28) limits) for some time now. The Seed Balanced Fund has been at (or near) its limits for much of its 5.5 year history – and this allocation has significantly contributed to the Fund’s returns. The rationale for most of this period has been that global assets offer better value than local assets and pressure on the rand to weaken.

To the end of October 2015 the rand weakened by 12.8% pa vs the US dollar over a 5 year period (6.96 ZAR/USD to 13.80 ZAR/USD) in a fairly linear fashion. From the end of October 2015 up to yesterday’s (18/01/16) close the rand further weakened by over 18% to the US dollar – a much sharper drop. While we believe that global investments still offer better value than their local counterparts, the argument for significantly more rand weakness has, excuse the pun, been weakened.

The question for investors who’ve had a sizeable allocation to global assets is, “What should I do now? Should I be repatriating my global assets?”

Seed’s view remains that investors should invest into well-constructed, diversified portfolios. We continue to see more value in global assets and therefore prefer to keep the global allocation in our Funds at/near their mandate limits. What isn’t so clear is where the rand will move from here. According to our Purchasing Power Parity (PPP) model the rand’s fair value is R10.42/USD, indicating that at current rates (R16.84/USD) the local currency is over 60% from fair value. The rand has only been weaker (relative to fair value) in the currency blow out of 2001. The chart below shows the rand vs the US dollar since the end of 1984 as well as the PPP level and a couple deviation lines from fair value (PPP). Naturally there is a risk that the rand continues to weaken from here, but history shows that PPP does have a strong pull over longer periods.

Practically, in the Seed Balanced Fund (our house view unit trust), we have implemented a zero cost currency collar on a portion of our global allocation. The structure protects a portion of the Fund from the rand strengthening below R16.47/USD AND allows that portion of the Fund to participate in further rand weakness up to a point (R19.70 – represented in the chart above) by the end of the year, all the while retaining exposure to global assets. Essentially the rand will need to weaken past its (relative) lows of 2001 before this structure starts costing the Fund – another 15% fall in the currency by year end.

We don’t proclaim to have a crystal ball that tells us what level the currency will be at by the end of the year, but based on our valuations (and understanding of global forces) our view is that there is a greater chance of the rand ending the year below R19.70/USD than above. Importantly, this structure is only on a portion of our global assets. Should we see further rand weakness we will have the opportunity to protect more of the Fund’s currency exposure.

Seed Weekly - Investing in 2016

Welcome to Seed’s first Weekly of the year. We trust that you had a good break, and have a successful 2016!

The political and financials ructions of the last month or two have been widely discussed and documented across media and around many braais over the summer holiday I am sure – so this Weekly won’t attempt to cover those events. Many people will have come back to their desks this year worrying about their investments, and how they should be positioned.

As professional investors we need to ensure that we separate emotion from fact when making investment decisions. Any sharp (negative) move in an asset class will result in high emotions (panic) and it’s our responsibility to assess why the move has occurred and whether the facts have changed. Should there be no rational reason for the asset class weakness it presents us with an excellent opportunity to buy, but if the facts have changed then the position needs to be reassessed. There is no doubt that South Africa’s global standing has been negatively affected over the past 2 months, but we need to assess to what extent this is now priced in.

Many/most investment companies in South Africa have been advocating having a material allocation to global assets (in a practical sense around 25% as per pension fund (Reg 28) limits) for some time now. The Seed Balanced Fund has been at (or near) its limits for much of its 5.5 year history – and this allocation has significantly contributed to the Fund’s returns. The rationale for most of this period has been that global assets offer better value than local assets and pressure on the rand to weaken.

To the end of October 2015 the rand weakened by 12.8% pa vs the US dollar over a 5 year period (6.96 ZAR/USD to 13.80 ZAR/USD) in a fairly linear fashion. From the end of October 2015 up to yesterday’s (18/01/16) close the rand further weakened by over 18% to the US dollar – a much sharper drop. While we believe that global investments still offer better value than their local counterparts, the argument for significantly more rand weakness has, excuse the pun, been weakened.

The question for investors who’ve had a sizeable allocation to global assets is, “What should I do now? Should I be repatriating my global assets?”

Seed’s view remains that investors should invest into well-constructed, diversified portfolios. We continue to see more value in global assets and therefore prefer to keep the global allocation in our Funds at/near their mandate limits. What isn’t so clear is where the rand will move from here. According to our Purchasing Power Parity (PPP) model the rand’s fair value is R10.42/USD, indicating that at current rates (R16.84/USD) the local currency is over 60% from fair value. The rand has only been weaker (relative to fair value) in the currency blow out of 2001. The chart below shows the rand vs the US dollar since the end of 1984 as well as the PPP level and a couple deviation lines from fair value (PPP). Naturally there is a risk that the rand continues to weaken from here, but history shows that PPP does have a strong pull over longer periods.

Practically, in the Seed Balanced Fund (our house view unit trust), we have implemented a zero cost currency collar on a portion of our global allocation. The structure protects a portion of the Fund from the rand strengthening below R16.47/USD AND allows that portion of the Fund to participate in further rand weakness up to a point (R19.70 – represented in the chart above) by the end of the year, all the while retaining exposure to global assets. Essentially the rand will need to weaken past its (relative) lows of 2001 before this structure starts costing the Fund – another 15% fall in the currency by year end.

We don’t proclaim to have a crystal ball that tells us what level the currency will be at by the end of the year, but based on our valuations (and understanding of global forces) our view is that there is a greater chance of the rand ending the year below R19.70/USD than above. Importantly, this structure is only on a portion of our global assets. Should we see further rand weakness we will have the opportunity to protect more of the Fund’s currency exposure.